Regional Liquidity Management in Asia - An Overview
It is likely that most businesses will look back on 2003 in very much the same way as 2002: relieved that a difficult year is over, but wary of the uncertainties lying ahead of them. 2004 will hopefully bring us a brighter horizon, although the outlook today still makes it a rather risky bet.
Economic recovery will probably be a slow process, the uncertainties associated with Iraq and the Middle East are likely to still be with us and, while we certainly hope that the SARS (Severe Acute Respiratory Syndrome) virus will not return, the world economy will also need to deal with the uncertainties associated with the American presidential race. Pressure on countries across Asia Pacific, particularly China, to revalue their currencies against the US dollar and the euro will grow as the US and Europe seek to re-balance their commercial flows with the region.
Faced with the above, most businesses will sensibly remain prudent and will not undertake major investments. However, the same does not and should not apply to cash management in general or to liquidity management in particular. A difficult economic environment only makes the case for efficient liquidity management more compelling and reinforces the need for the treasurers to shake up the status quo to make the company’s cash work harder.
In the aftermath of the 1997 Asian crisis, hopes were high that the need for reforms across most Asian economies would lead to deregulation and a gradual easing of the traditional hurdles preventing the implementation of efficient liquidity management structures in the region. A few changes did take place, such as the interest rate deregulation that took place in Singapore and in the Hong Kong Special Administrative Region, the development of entrusted loans and the recent authorisation granted to some local and foreign banks to offer overdraft facilities in China. However, none of this has made the treasurer’s task of managing liquidity on a regional basis any easier:
Faced with such a difficult environment, it is nonetheless possible to implement successful strategies to manage liquidity regionally. Devising and implementing such strategies requires the company to make certain critical choices, such as creating a centralised treasury structure, choosing the right banking partner, knowing how to leverage the company’s trade flows, and favouring electronic payment means over traditional paper instruments.
Should treasury-related decisions be centralised or decentralised? The answer will vary from one company to the next, and will depend not only upon the company’s culture, but also its level of development and maturity.
However, for companies that are at the stage of considering the opportunity of managing their liquidity regionally, few will argue for a decentralised structure. The pendulum has swung very much in favour of a centralised treasury function. The objective of managing the company’s regional cash position as a group resource implies the need for the underlying subsidiaries to relinquish control, at least partially, over the underlying balances to the regional treasury team.
On the other hand, one would expect the regional treasury team to be located within the region, typically in Hong Kong or Singapore. Some companies do try to manage their regional treasury operations from outside of Asia Pacific. In some instances, this may be a perfectly valid choice, driven possibly by cost considerations and the necessary critical mass to justify the implementation of a fully-fledged regional treasury centre. However, one would argue that this is a compromise and that such a solution is suboptimal for cash management:
A caveat to the above would be that the implementation of a centralised treasury model in Asia Pacific should be carried out sensibly. Purists of the centralisation model may argue for the concentration of most treasury functions to the centre. However, the specifics of key markets such as China or India call for the maintenance of some on-the-ground expertise and decision-making capacity.
In Europe, companies will often differentiate between the regional overlay bank and the banks chosen to handle their domestic cash management needs in individual markets. Such a model is rarely seen in Asia where local idiosyncrasies, the relative unpopularity of third-party banking arrangements, and the absence of a common regional payment infrastructure would often hamper the timely transfer of funds between the overlay and the domestic banks required to enable the daily management of cash balances. The relative strengths and credit ratings of local banks are another reason why multinational groups will often want to avoid direct relationships with local institutions.
The choice of a banking partner to implement a regional liquidity solution will therefore not be limited to an overlay structure. It will impact both the company’s regional and domestic banking arrangements, as one is required to consolidate the company’s cash management business under a single roof with a single institution or to move it to the local banks with which the chosen regional service provider has established specific alliances. The special characteristics of the Asian market reinforce the need for the regional treasury to be given a strong mandate to support the regional implementation, combined with sufficient communication with the local subsidiaries to ensure their buy-in into the final decision.
With the implementation of an efficient regional liquidity management structure comes an implicit objective from the treasury team to outsource most of the underlying day-to-day processes. Doing so involves a high level of commitment from the cash management bank in terms of resources, regional reach and technology such that it is able to:
The above considerations should drive the treasurers towards a vigorous selection process to identify the institution with the best potential fit with the company. The provision of cash management products is a value-added service for which price cannot be the sole consideration. Treasurers need to assess the potential bidders in terms of service quality, advice and consulting skills, geographical reach and fit with the company, technology, coherence of the regional product suite, and its integration with the required delivery channel.
The options opened to treasurers are actually relatively limited. Only a handful of global or regional institutions have the capabilities required to support the implementation of a regional liquidity management mandate. Although treasurers have a duty to come to the market every three years or so, they should really seek an institution with which the company will comfortably be able to develop a long-term and mutually beneficial partnership that should quickly outgrow the traditional limits of cash management.
The regional liquidity management solutions that banks can offer will invariably be based upon a combination of notional pooling and/or domestic and cross-border cash concentration. These solutions are well known and provide clearly identified benefits. They also have well defined drawbacks:
More importantly, the use of notional pooling and/or cash concentration remains tightly regulated and is either restricted or simply not allowed in many countries around the region. This situation, combined with the prevalent foreign exchange restrictions, often turn specific markets into liquidity traps where the only options to get cash out of the country are through the payment of dividends or the settlement of import transactions.
Companies often approach banks seeking solutions for making use of the surplus cash they hold in markets such as China, Korea, the Philippines and Taiwan. Apart from paying credit interest on such balances (where allowed), there is often little that the banks can do to help.
On the other hand, treasurers can do a lot to help themselves. They can simply leverage the underlying inter-company trade flows generated by the company’s subsidiaries across the region and implement leading and lagging. “Leading” is paying early to a cash-poor subsidiary, thus saving the subsidiary from drawing on its overdraft facility. “Lagging” means paying cash-rich subsidiaries later. Doing so will effectively move liquidity from the cash-rich to the cash-poor entities with little or no tax considerations, as the underlying transactions will, under normal circumstances, not be treated as inter-company loans and will not require the payment of interest.
The existence of a regional treasury centre, which can also act as a reinvoicing or an internal factoring centre, facilitates the use of leading and lagging. Reinvoicing is a process where subsidiaries, in lieu of billing their own customers directly, will bill the regional treasury centre, which in turn invoices the customer. The latter may or may not be a subsidiary of the group. The treasury centre can thus implement leading and lagging by granting different credit periods to the cash-poor or cash-rich entities. Another key benefit of such a structure is the centralisation of the company’s foreign exchange exposure, as the subsidiaries will typically bill the treasury centre in their home currency while the treasury centre invoices customers in the customers’ home currency.
Internal factoring provides similar if not identical benefits. In a group that uses factoring, the subsidiary first bills its customer, but then sells the receivables to the in-house factoring centre. The discount is usually at a preferential rate, lower than the rate that would otherwise be obtained from a bank.
The availability of timely and accurate cash flow forecasts is an essential requirement for regional treasurers to manage the company’s liquidity efficiently. The advance knowledge that funding is required gives treasurers sufficient time to look for the cheapest source of funds, whether through inter-company loans or from the market, thereby minimising the cost of funds. Similarly, knowing that a cash surplus will occur in advance enables treasurers to look for the most attractive investment opportunity, whether through termed deposits or money market funds.
Arguably, the growing availability of outsourcing solutions such as notional pooling and cash concentration could be considered as having reduced the need for cash forecasts. By automatically netting the underlying debit and credit balances, whether notionally or not, these tools ensure that the company is able to leverage its internal liquidity fully to minimise its funding costs.
Similarly, notional pooling and cash concentration facilitate the investment of the company’s cash balances by automatically aggregating cash surpluses. These surpluses can then be invested through an interest-bearing account or by setting up an automated two-way sweep into a money market fund.
The need for proper forecasting still remains. Although automated solutions such as notional pooling and cash concentration have reduced treasurers’ involvement in the day-to-day management of the company’s cash, treasurers need forecasts to understand the dynamics of the underlying cash flows and be able to determine:
Also, to move a cash surplus in one currency to fund a deficit in another currency, treasurers will often use currency swaps, which are facilitated by accurate forecasts regarding the availability of the surplus funds.
Owing to the above considerations, one of key objectives of treasurers should be the elimination of potential sources of uncertainty that complicate cash flow forecasts and ultimately lead to unnecessary idle balances being left in the company’s accounts. From this perspective, the use of cheques as a payment instrument should be challenged whenever and wherever possible in favour of alternative electronic payment means.
Cheque float has long been considered a key tool for companies to hold onto cash for as long as possible. However, the uncertainty associated with the time of cheque presentation and the associated volatility in the company’s cash balance forces it to maintain a cash cushion, the impact of which may easily be greater than the benefits generated from cheque float.
Over the past year, the environmental difficulties associated with regional liquidity management have remained as challenging as before. However, this does not undermine the case for pursuing the optimum solution. Companies that are able to leverage their liquidity are able to achieve significant benefits either through reduced costs of funding or better investment opportunities.
The core of the solution is likely to rest on a degree of outsourcing such as notional pooling or cash concentration provided by a company’s chosen bank. However, the success of a regional liquidity management structure also depends upon the company’s ability to make a few critical choices, without which it may not be able to maximise the structure’s benefits.